Power matters, Cyprus edition

This from "Stumbling and Mumbling" - please follow link to original
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http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/

It's widely agreed that the EU's plan to penalize smaller depositors in Cyprus's banks is a terrible idea, because as Paul Krugman says:

It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying “time to stage a run on your banks!”

But if it's such a bad idea, why do it? The answer lies in something known by Marxists and heterodox economists, but which orthdox economics still has trouble acknowledging. Quite simply, the allocation of wealth, or costs, depends upon power.

Let's put it this way. Who could pay for Cyprus's insolvent banks? The answer isn't their bond-holders, because these are almost non-existent, and nor is it shareholders, as even a 100% loss for them doesn't cover the banks' liabilities.

In principle, Cyprus's government could have bailed out the banks. But this would have left it insolvent, requiring a bail-out itself. That would have imposed losses on holders of Cypriot government debt, such as European banks and hedge funds. But such holders had the power to resist this - in part because of the credibleish threat that such losses would have weakened confidence in the general European financial system, and as Kalecki said, "confidence" is one of the tools whereby capitalists retain power over the economy and governments.Pawelmorski says:

The hedge funds win again. A favourite trade for speculators has been Cypriot government debt. And it’s done very nicely. Mayfair sends its thanks.

This leaves only two possible payers. One is German tax-payers. But these have the obvious bargaining power of having little to lose if no agreement is reached.

The other possibility is that larger depositors in Cyprus's banks pay more - these being Russian gangsters legitimate businessmen and Greek tax-dodgers. But naturally, the rich have the power; the joke that Cypriot president Nicos Anastasiades "has only rich friends" gains power from its plausibility.

As a matter of elimination, therefore, smaller depositors - those who supposedly had a "guarantee" must pay. They do so not because of any principle of fairness or efficiency, but because they lack the power to protect their interests. What we're seeing here, says Pawelmorski, is "a cruel piece of realpolitik."

One quirk here is that its possible that these haircuts are a backdoor way of channeling Cyprus's large gas reserves into Russian hands. This, of course, in no way undermines my point, which is that economic allocations are determined by power.

My point here is not just about Cyprus. It's about economics generally. If we cannot understand Cyprus's situation without thinking about power relationships, why should we assume that we can ignore power in other aspects of economics, such as the everyday transactions that have led to rising inequality?

The answer, of course, is that we can't. Power matters more than fairness or efficiency. It's about time conventional economics cottoned onto this.